##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   INSURANCE AUTO AUCTIONS, INC.
  Illinois
(State or other jurisdiction of
incorporation or organization)
    
    95-3790111
(I.R.S. Employer
Identification No.)
 Two Westbrook Corporate Center, Suite 500, Westchester, Illinois 60154
 (708) 492-7000
  ̈ þ
   ̈  ̈ þ
  ̈ þ




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INSURANCE AUTO AUCTIONS, INC.
 Form 10-Q
 Table of Contents
 Page NumberPart I. Financial InformationItem 1. Financial Statements (Unaudited)Condensed Consolidated Balance Sheets
    
    
    1Condensed Consolidated Statements of Operations
    
    
    2Condensed Consolidated Statements of Cash Flows
    
    
    3Notes to Condensed Consolidated Financial Statements
    
    
    4Item 2. Managements Discussion and Analysis of Financial Condition
and Results of Operations
    
    
    16Overview
    
    
    16Significant Items Affecting Comparability
    
    
    16Acquisitions and New Operations
    
    
    17Results of Operations
    
    
    17Financial Condition and Liquidity
    
    
    19Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    22Item 4. Controls and Procedures
    
    
    23Part II. Other Information
    
    
    24Item 1. Legal Proceedings
    
    
    24Item 1A. Risk Factors
    
    
    24Item 6. Exhibits
    
    
    24Signatures
    
    
    25Section 302 Certification by CEOSection 302 Certification by CFOSection 906 Certification by CEOSection 906 Certification by CFO




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##### Table of Contents



Part I
Financial Information
 
 INSURANCE AUTO AUCTIONS, INC. AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands except per share amounts)
 SUCCESSOR
    
    
    SUCCESSORJune 25,
    
    
    December 25,2006
    
    
    2005(unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    25,619
    
    
    $
    25,882Accounts receivable, net
    
    
    47,007
    
    
    
    46,920Inventories
    
    
    21,099
    
    
    
    19,611Income taxes receivable
    
    
    3,751
    
    
    
    2,732Deferred income taxes
    
    
    6,512
    
    
    
    8,511Other current assets
    
    
    6,039
    
    
    
    5,323Total current assets
    
    
    110,027
    
    
    
    108,979Property and equipment, net
    
    
    78,230
    
    
    
    77,231Intangible assets, net
    
    
    122,565
    
    
    
    126,378Goodwill
    
    
    206,628
    
    
    
    191,266Other assets
    
    
    10,488
    
    
    
    11,006$
    527,938
    
    
    $
    514,860LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    44,883
    
    
    $
    38,022Accrued liabilities
    
    
    18,736
    
    
    
    17,445Obligations under capital leases
    
    
    334
    
    
    
    367Obligations under line of credit
    
    
    7,000
    
    
    
    Current installments of long-term debt
    
    
    1,143
    
    
    
    1,143Total current liabilities
    
    
    72,096
    
    
    
    56,977Deferred income taxes
    
    
    35,892
    
    
    
    37,582Other liabilities
    
    
    12,415
    
    
    
    12,765Obligations under capital leases
    
    
    158
    
    
    
    329Senior notes
    
    
    150,000
    
    
    
    150,000Long-term debt, excluding current installments
    
    
    112,610
    
    
    
    113,183Total liabilities
    
    
    383,171
    
    
    
    370,836Shareholders equity:Common stock, par value of $.01 per share100 shares authorized, issued and outstanding
    
    
    
    
    
    
    Additional paid-in capital
    
    
    150,776
    
    
    
    149,458Retained loss
    
    
    (6,009
    )
    
    
    (5,434
    )Total shareholders equity
    
    
    144,767
    
    
    
    144,024$
    527,938
    
    
    $
    514,860
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INSURANCE AUTO AUCTIONS, INC. AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands)
 THREE MONTHS
    
    
    SIX MONTHS(unaudited)
    
    
    (unaudited)SUCCESSOR
    
    
    SUCCESSOR
    
    
    PREDECESSOR
    
    
    SUCCESSOR
    
    
    SUCCESSOR
    
    
    PREDECESSORMay 25 
    
    
    March 28 
    
    
    
    
    
    
    May 25 
    
    
    December 27,June 25
    
    
    June 26,
    
    
    May 24,
    
    
    June 25,
    
    
    June 26,
    
    
    2004  May 24,2006
    
    
    2005
    
    
    2005
    
    
    2006
    
    
    2005
    
    
    2005Revenues:Fee income
    
    $
    66,366
    
    
    $
    19,242
    
    
    $
    42,102
    
    
    $
    133,145
    
    
    $
    19,242
    
    
    $
    103,203Vehicle sales
    
    
    11,938
    
    
    
    3,119
    
    
    
    7,399
    
    
    
    22,812
    
    
    
    3,119
    
    
    
    17,24278,304
    
    
    
    22,361
    
    
    
    49,501
    
    
    
    155,957
    
    
    
    22,361
    
    
    
    120,445Cost of SalesBranch cost
    
    
    49,975
    
    
    
    14,481
    
    
    
    29,877
    
    
    
    98,219
    
    
    
    14,481
    
    
    
    72,554Vehicle cost
    
    
    10,178
    
    
    
    2,652
    
    
    
    6,175
    
    
    
    19,351
    
    
    
    2,652
    
    
    
    14,64060,153
    
    
    
    17,133
    
    
    
    36,052
    
    
    
    117,570
    
    
    
    17,133
    
    
    
    87,194Gross profit
    
    
    18,151
    
    
    
    5,228
    
    
    
    13,449
    
    
    
    38,387
    
    
    
    5,228
    
    
    
    33,251Operating expense:Selling, general and
administrative
    
    
    11,377
    
    
    
    3,400
    
    
    
    5,773
    
    
    
    23,236
    
    
    
    3,400
    
    
    
    15,822Loss (gain) on sale
of property and
equipment
    
    
    11
    
    
    
    17
    
    
    
    (864
    )
    
    
    17
    
    
    
    17
    
    
    
    (896
    )Loss related to flood
    
    
    310
    
    
    
    
    
    
    
    
    
    
    
    3,170
    
    
    
    
    
    
    
    Merger costs
    
    
    
    
    
    
    5,021
    
    
    
    14,508
    
    
    
    
    
    
    
    5,021
    
    
    
    15,74111,698
    
    
    
    8,438
    
    
    
    19,417
    
    
    
    26,423
    
    
    
    8,438
    
    
    
    30,667Earnings (loss)
from operations
    
    
    6,453
    
    
    
    (3,210
    )
    
    
    (5,968
    )
    
    
    11,964
    
    
    
    (3,210
    )
    
    
    2,584Other (income) expenseInterest expense
    
    
    6,741
    
    
    
    2,642
    
    
    
    148
    
    
    
    13,193
    
    
    
    2,642
    
    
    
    567Other income
    
    
    (123
    )
    
    
    (41
    )
    
    
    (2,411
    )
    
    
    (246
    )
    
    
    (41
    )
    
    
    (2,442
    )Earnings (loss)
before income taxes
    
    
    (165
    )
    
    
    (5,811
    )
    
    
    (3,705
    )
    
    
    (983
    )
    
    
    (5,811
    )
    
    
    4,459Income taxes
    
    
    (94
    )
    
    
    (1,311
    )
    
    
    1,756
    
    
    
    (408
    )
    
    
    (1,311
    )
    
    
    4,899Net loss
    
    $
    (71
    )
    
    $
    (4,500
    )
    
    $
    (5,461
    )
    
    $
    (575
    )
    
    $
    (4,500
    )
    
    $
    (440
    )
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INSURANCE AUTO AUCTIONS, INC. AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 SUCCESSOR
    
    
    PREDECESSORDecember 27,June 25,
    
    
    May 25 
    
    
    2004 2006
    
    
    June 26, 2005
    
    
    May 24, 2005(unaudited)
    
    
    (unaudited)
    
    
    (unaudited)Cash flows from operating activities:Net loss
    
    $
    (575
    )
    
    $
    (4,500
    )
    
    $
    (440
    )Adjustments to reconcile net loss to net cash
provided by operating activities:Depreciation and amortization
    
    
    10,573
    
    
    
    1,859
    
    
    
    5,464(Gain) loss on disposal of fixed assets
    
    
    817
    
    
    
    17
    
    
    
    (896
    )Share-based compensation expense
    
    
    1,168
    
    
    
    
    
    
    
    Amortization
of debt costs
    
    
    723
    
    
    
    60
    
    
    
    Deferred compensation related to restricted stock
    
    
    
    
    
    
    
    
    
    
    4,343Deferred income taxes
    
    
    2,054
    
    
    
    1,489
    
    
    
    (1,448
    )Tax benefit related to employee stock compensation
    
    
    
    
    
    
    678
    
    
    
    8,394Changes in assets and liabilities (excluding effects of acquired companies):(Increase) decrease in:Accounts receivable, net
    
    
    964
    
    
    
    13,880
    
    
    
    (5,312
    )Income tax receivable
    
    
    (931
    )
    
    
    (7,464
    )
    
    
    (2,618
    )Inventories
    
    
    (1,165
    )
    
    
    124
    
    
    
    (472
    )Other current assets
    
    
    (616
    )
    
    
    (2,574
    )
    
    
    (520
    )Other assets
    
    
    (52
    )
    
    
    (72
    )
    
    
    (827
    )Increase (decrease) in:Accounts payable
    
    
    6,861
    
    
    
    (20,321
    )
    
    
    6,719Accrued liabilities
    
    
    (79
    )
    
    
    (7,308
    )
    
    
    12,279Income taxes
    
    
    
    
    
    
    
    
    
    
    (1,067
    )Total adjustments
    
    
    20,317
    
    
    
    (19,632
    )
    
    
    24,039Net cash provided by (used in) operating activities
    
    
    19,742
    
    
    
    (24,132
    )
    
    
    23,599Cash flows from investing activities:Purchase of IAAI., Inc.
    
    
    
    
    
    
    (356,753
    )
    
    
    Capital expenditures
    
    
    (8,123
    )
    
    
    (1,612
    )
    
    
    (8,221
    )Acquisition, net of cash acquired
    
    
    (18,418
    )
    
    
    
    
    
    
    (600
    )Proceeds from disposal of property and equipment
    
    
    291
    
    
    
    22
    
    
    
    1,391Net cash used in investing activities
    
    
    (26,250
    )
    
    
    (358,343
    )
    
    
    (7,430
    )Cash flows from financing activities:Proceeds from issuance of common stock
    
    
    
    
    
    
    
    
    
    
    905Contributed capital
    
    
    150
    
    
    
    143,600
    
    
    
    Proceeds from short-term borrowings
    
    
    7,000
    
    
    
    
    
    
    
    3,000Payment of financing and other fees
    
    
    (128
    )
    
    
    (12,758
    )
    
    
    Principal payments on long-term debt
    
    
    (573
    )
    
    
    (22,125
    )
    
    
    (3,762
    )Purchase of treasury stock
    
    
    
    
    
    
    
    
    
    
    (1
    )Principal payments on capital leases
    
    
    (204
    )
    
    
    (79
    )
    
    
    (614
    )Issuance of senior notes
    
    
    
    
    
    
    150,000
    
    
    
    Issuance of term loan
    
    
    
    
    
    
    115,000
    
    
    
    Net cash provided by (used in) financing activities
    
    
    6,245
    
    
    
    373,638
    
    
    
    (472
    )Net increase (decrease) increase in cash and cash equivalents
    
    
    (263
    )
    
    
    (8,837
    )
    
    
    15,697Cash and cash equivalents at beginning of period
    
    
    25,882
    
    
    
    29,022
    
    
    
    13,325Cash and cash equivalents at end of period
    
    $
    25,619
    
    
    $
    20,185
    
    
    $
    29,022Supplemental disclosures of cash flow information:Interest paid
    
    $
    12,623
    
    
    $
    9
    
    
    $
    689Income taxes paid
    
    $
    436
    
    
    $
    3,987
    
    
    $
    1,654Income taxes refunded
    
    $
    1,966
    
    
    $
    
    
    
    $
    26Non-cash transactions:Options exchanged in merger transaction
    
    $
    
    
    
    $
    5,653
    
    
    $
    
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INSURANCE AUTO AUCTIONS, INC. AND SUBSIDIARIES
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 (1)
    
    Summary of Business and Significant Accounting PoliciesAs used in these notes, unless the context requires otherwise, the Company, IAAI, we,
us, our, and other similar terms refer to Insurance Auto Auctions, Inc. and its
subsidiaries. IAAI is a wholly-owned subsidiary of Axle Holdings, Inc., a Delaware
corporation (Axle Holdings), which is a wholly-owned subsidiary of Axle Holdings II, LLC,
a Delaware limited liability company (LLC) that is controlled by affiliates of Kelso &
Company, L.P. (Kelso). Kelso owns 84.4 % of the LLC; Parthenon Investors II, L.P. and its
affiliates (Parthenon) own 10.4% of the LLC; Magnetite Asset Investors III, L.L.C., Brian
Clingen and Dan Simon (the other investors) own approximately 4.9% of the LLC; and Company
management owns the remaining 0.3% of the LLC.BackgroundIAAI operates in a single business segmentproviding insurance companies and other vehicle
suppliers cost-effective salvage processing solutions, including selling total loss and
recovered theft vehicles. Fiscal year 2005 consisted of 52 weeks and ended on December 25,
2005. Fiscal year 2006 consists of 53 weeks and will end on December 31, 2006.On May 25, 2005, the Company completed the merger transactions that are described in Note 2
below. These transactions resulted in many differences between reporting for IAAI
post-merger, as successor, and IAAI pre-merger, as predecessor. The accompanying condensed
consolidated financial statements and the notes to the condensed consolidated financial
statements reflect separate reporting periods for the predecessor and successor company
where applicable.Principles of ConsolidationThe accompanying unaudited condensed consolidated financial statements include the accounts
of IAAI and its wholly-owned subsidiaries and have been prepared in accordance with
accounting principles generally accepted in the United States (GAAP) for interim financial
reporting and in accordance with Rule 10-01 of Regulation S-X. Accordingly, they do not
include all of the information and notes required by GAAP for complete financial statements.In the opinion of management, the accompanying unaudited condensed consolidated financial
statements contain all adjustments (consisting of normal recurring items, unless otherwise
noted) necessary for a fair presentation of results for the interim periods presented. The
results of operations for any interim period are not necessarily indicative of results to be
expected for a full year. The condensed consolidated balance sheet of the Company at
December 25, 2005, has been derived from audited financial statements but does not include
all disclosures required by GAAP. These financial statements and footnote disclosures should
be read in conjunction with the Companys audited consolidated financial statements and
notes thereto for the year ended December 25, 2005, which appear in the Companys Annual
Report on Form 10-K filed with the Securities and Exchange Commission on March 27, 2006 and
Amendment No. 1 thereto filed on March 31, 2006.Disclosures About Fair Value of Financial InstrumentsThe Companys financial instruments include cash and cash equivalents, accounts receivable
and long-term debt. The fair values of these instruments approximate their carrying values
other than long-term debt. As of June 25, 2006, the fair value of the Companys 11% Senior
Notes due 2013 was $147.0 million, and the fair value of the Companys term loan under its
senior credit facilities was $114.0 million.
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Use of EstimatesThe preparation of financial statements in conformity with GAAP requires management to make
estimates and assumptions that affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual amounts could differ from those estimates and assumptions.Stock Based CompensationThe matter discussed in this Note should be read in conjunction with the disclosures
contained in Note 8. In December 2004, the Financial Accounting Standards Board (FASB)
issued SFAS No. 123R, Share-Based Payment(SFAS 123R). SFAS 123R is a revision of SFAS
No. 123, Accounting for Stock-Based Compensation(SFAS 123), and supersedes Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees(APB 25), and
its related implementation guidance. On December 26, 2005, the Company adopted the
provisions of SFAS 123R using the prospective method. Under the prospective method, the
Company accounts for awards outstanding as of December 25, 2005 using the accounting
principles originally applied, SFAS 123 and APB 25. For awards issued after December 25,
2005 and for awards modified, repurchased or cancelled after December 25, 2005, the Company
accounts for awards at fair value using the accounting principles under SFAS 123R. The
Company is permitted to apply the prospective method under SFAS 123R because the Company
elected to use the minimum value method of measuring share options for pro forma disclosure
purposes under SFAS123 in prior periods. Had the Company elected to use the fair value
method for pro forma disclosure purposes under SFAS 123, it would have been required to
recognize more compensation expense in the Statement of Operations under SFAS 123R for
periods beginning on or after December 25, 2005.SFAS 123R requires entities to recognize compensation expense for awards of equity
instruments to employees based on the grant-date fair value of those awards. SFAS 123R also
requires the benefits of tax deductions in excess of recognized compensation expense to be
reported as a financing cash flow, rather than as an operating cash flow as prescribed under
the prior accounting rules. This requirement reduces net operating cash flows and increases
net financing cash flows in periods after adoption. Total cash flow remains unchanged from
what would have been reported under prior accounting rules.Prior to the adoption of SFAS 123R, the Company followed the intrinsic value method in
accordance with APB 25 to account for its employee stock options. Accordingly, compensation
expense was recognized when the fair value of the grant exceeded the exercise price. The
adoption of SFAS 123R primarily resulted in a change in the Companys method of recognizing
the market value of share based compensation and estimating forfeitures for all unvested
awards. Specifically, the adoption of SFAS 123R resulted in the recording of compensation
expense for employee stock options. The effect of adopting SFAS 123R
was an increase in compensation expense of $0.2 million
($0.1 million after tax) for the three months ended
June 25, 2006 and $0.3 million ($0.2 million after
tax) for the six months ended June 25, 2006.There was no material impact to the operating or financing
cash flow or net loss in the period of adoption. When applying the prospective method, the Company is not
permitted to provide pro forma disclosures as was previously required under SFAS 123. As a
result of the merger transactions described in Note 2 below, the Companys capital structure
and its stock compensation plans changed significantly. Consequently, the stock based
compensation information for the six months ended June 25, 2006 is not comparative to the
six months ended June 26, 2005. As such, comparative data is not presented in the Notes
related to stock based compensation.Recent Accounting PronouncementsIn February 2006, the FASB issued Statement of Financial Accounting Standards No. 155 (SFAS
155), Accounting for Certain Hybrid Financial Instruments, which amends FASB Statements
No. 133 (SFAS 133), Accounting for Derivative Instrument and Hedging Activities and No.
140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities. SFAS 155 eliminates the exemption of applying SFAS 133 to interests in
securities and financial assets so that similar instruments are accounted for similarly
regardless of the term of the instruments. The Company will adopt this new accounting
standard at the beginning of its annual reporting period that begins after September 15,
2006. The Company is currently
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evaluating the impact of the adoption of SFAS 155 on its financial statements, although it
presently does not anticipate the adoption of SFAS 155 to have a material impact on the
Companys financial statements.In March 2006, the FASB issued Statement of Financial Accounting Standards No. 156 (SFAS
156), Accounting for Servicing of Financial Assets  an amendment of FASB Statement No.
140. SFAS 156 requires an entity to recognize a servicing asset or servicing liability
each time it undertakes an obligation to service a financial asset by entering into a
servicing contract under certain conditions. The Company will adopt this new accounting
standard at the beginning of its annual reporting period that begins after September 15,
2006. The Company is currently evaluating the impact of the adoption of SFAS 156 on its
financial statements, although it presently does not anticipate the adoption of SFAS 156 to
have a material impact on its financial statements.In March 2006, the FASB issued FASB Interpretation No. 48 (FIN 48), Accounting for
Uncertainty in Income Taxes, an interpretation of FASB Statement 109. The statement seeks
to clarify the significant diversity in practice associated with financial statement
recognition and measurement in accounting for income taxes. The Company will adopt this new
standard at the beginning of its annual reporting period that begins after December 15,
2006. The Company is currently evaluating the impact of the adoption of FIN 48 on its
financial statements.(2)
    
    Merger TransactionsEffective May 25, 2005, IAAI became a direct, wholly-owned subsidiary of Axle Holdings,
which is owned by the LLC (which is controlled by Kelso). As part of the merger
transactions, IAAI entered into new senior credit facilities, comprised of a $50.0 million
revolving credit facility and a $115.0 million term loan, which were guaranteed by all of
IAAIs then existing domestic subsidiaries. As part of the merger transactions, IAAI also
issued $150.0 million of 11% Senior Notes due 2013. IAAI received approximately $143.6
million of cash equity contributions from Kelso, Parthenon, the other investors and certain
members of management in connection with the merger transactions.IAAI used the net proceeds of these financings and equity contributions to: (i) fund the
cash consideration payable to the Companys shareholders and option holders under the merger
agreement; (ii) repay outstanding principal and accrued interest under the Companys prior
credit facility; and (iii) pay related transaction fees and expenses.The merger was recorded in accordance with Statement of Financial Accounting Standards No.
141 (SFAS 141). The Company has made certain adjustments to increase or decrease the
carrying amount of assets and liabilities as a result of estimates and certain assumptions
the Company believes are reasonable, which, in a number of instances, has resulted in
changes to amortization and depreciation expense amounts. The estimates are based upon
valuations and information currently available and are derived from managements estimates
and judgment. The Company believes that the valuations and estimates are a reasonable basis
for the allocation of the purchase price. During the quarter ended June 25, 2006, the
Company refined its estimates and, as a result, it recorded an increase in current
liabilities and fixed assets of $0.3 million, a decrease in deferred tax liability of $2.0
million, a decrease in deferred tax asset of $0.1 million, and a corresponding decrease in
goodwill of $1.8 million. The following table summarizes the estimated fair value of the
assets acquired and liabilities assumed (in thousands):
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Current assets
    
    $
    110,208Property, plant, & equipment.
    
    
    75,957Deferred income tax asset.
    
    
    15,023Goodwill
    
    
    188,990Income tax receivable
    
    
    4,485Intangibles.
    
    
    131,500Debt issuance cost
    
    
    9,357Other
    
    
    760Total assets
    
    $
    536,280Current liabilities
    
    $
    60,312Capital lease obligation
    
    
    1,142Senior notes
    
    
    150,000Credit facilities
    
    
    115,000Deferred income tax liability
    
    
    44,540Unfavorable leases
    
    
    3,800Other
    
    
    12,233Total liabilities
    
    $
    387,027Net assets acquired
    
    $
    149,253
  Significant Items Affecting Comparability
   Three Months Ended
    
    
    Six Months EndedJune 25,
    
    
    June 26,
    
    
    June 25,
    
    
    June 26,2006
    
    
    2005
    
    
    2006
    
    
    2005Revenue
    
    $
    78,304
    
    
    $
    71,862
    
    
    $
    155,957
    
    
    $
    142,806Earnings (loss) before taxes
    
    
    (165
    )
    
    
    (15,246
    )
    
    
    (983
    )
    
    
    (13,848
    )Earnings (loss)
    
    
    (71
    )
    
    
    (13,571
    )
    
    
    (575
    )
    
    
    (12,812
    )
  7




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##### Table of Contents



(3)
    
    Accounts ReceivableAccounts receivable consisted of the following as of June 25, 2006 and December 25, 2005
(dollars in thousands):
 Successor
    
    
    SuccessorJune 25,
    
    
    December 25,2006
    
    
    2005(unaudited)Unbilled receivables
    
    $
    33,945
    
    
    $
    35,534Trade accounts receivable
    
    
    12,142
    
    
    
    11,458Other receivables
    
    
    1,321
    
    
    
    41247,408
    
    
    
    47,404Less allowance for doubtful accounts
    
    
    (401
    )
    
    
    (484
    )$
    47,007
    
    
    $
    46,920
  (4)
    
    Property and EquipmentProperty and equipment consisted of the following at June 25, 2006 and December 25, 2005
(dollars in thousands):
 Successor
    
    
    SuccessorJune 25,
    
    
    December 25,2006
    
    
    2005(unaudited)Land
    
    $
    5,051
    
    
    $
    5,051Buildings and improvements
    
    
    9,245
    
    
    
    6,534Equipment
    
    
    23,589
    
    
    
    27,295Leasehold improvements
    
    
    53,603
    
    
    
    44,52591,488
    
    
    
    83,405Less accumulated depreciation
and amortization
    
    
    (13,258
    )
    
    
    (6,174
    )$
    78,230
    
    
    $
    77,231
  (5)
    
    Goodwill and Other IntangiblesThe Company performed its annual impairment test during the second quarter of this year.
This years annual impairment test did not indicate any impairment.
 8




---



##### Table of Contents



AmountBalance at December 25, 2005
    
    $
    191,266Acquisition of NW Penn Auction Sales
    
    
    2,295Adjustments to Kelso Merger Transaction
    
    
    (264
    )Balance at March 26, 2006
    
    
    193,297Acquisition of Indiana Auto Salvage Pool
    
    
    14,670Acquisition of NW Penn Auction Sales
    
    
    18Adjustments to Kelso merger transaction
    
    
    (1,863
    )Earn-out and valuation adjustment for prior year acquisition
    
    
    506Balance at June 25, 2006
    
    $
    206,628
   CostJune 25,
    
    
    December 25,Assigned Life
    
    
    2006
    
    
    2005(dollars in millions)SuccessorGoodwill
    
    Indefinite
    
    $
    206.6
    
    
    $
    191.3Supplier relationships
    
    20 years
    
    
    102.5
    
    
    
    102.5Trade names
    
    15 years
    
    
    14.9
    
    
    
    14.9Software
    
    6 years
    
    
    13.5
    
    
    
    13.5Covenants not to compete
    
    12 to 60 months
    
    
    1.3
    
    
    
    0.7$
    338.8
    
    
    $
    322.9
 Accumulated AmortizationJune 25,
    
    
    December 25,Assigned Life
    
    
    2006
    
    
    2005(dollars in millions)SuccessorSupplier relationships
    
    20 years
    
    $
    (5.6
    )
    
    $
    (3.1
    )Trade names
    
    15 years
    
    
    (1.1
    )
    
    
    (0.6
    )Software
    
    6 years
    
    
    (2.4
    )
    
    
    (1.3
    )Covenants not to compete
    
    12 to 60 months
    
    
    (0.6
    )
    
    
    (0.2
    )$
    (9.7
    )
    
    $
    (5.2
    )
  9




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##### Table of Contents



(6)
    
    Long-term DebtLong-term debt consisted of the following at the June 25,
2006 and December 25, 2005.
 Successor
    
    
    SuccessorJune 25,
    
    
    December 25,2006
    
    
    2005(dollars in thousands)11% senior notes
    
    $
    150,000
    
    
    $
    150,000Senior secured credit facilities
    
    
    113,753
    
    
    
    114,326263,753
    
    
    
    264,326Less current installments
    
    
    1,143
    
    
    
    1,143$
    262,610
    
    
    $
    263,183
 Senior Notes
  Credit Facilities
   10




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##### Table of Contents



(7)
    
    Income TaxesIncome taxes were computed using the effective tax rates estimated to be applicable for the
full fiscal years, which are subject to ongoing review and evaluation by us.The income tax receivable as of June 25, 2006 is due to the recording of a federal
income tax benefit expected to be utilized in 2006.The income tax benefit of $0.4 million for the June 25, 2006 year to date period was based
on our expected effective tax rate for the 2006 fiscal year.We evaluate the realizability of our deferred tax assets on an ongoing basis. In assessing
the realizability of deferred tax assets, we consider whether it is more likely than not
that some portion or all of the deferred tax assets will not be realized. The ultimate
realization of deferred tax assets is dependent upon the generation of future taxable income
during the periods in which those temporary differences become deductible. Management
considers the scheduled reversal of deferred tax liabilities, projected future taxable
income, and tax planning strategies in making this assessment. Based upon the level of
historical taxable income and projections for future taxable income over the periods in
which the deferred tax assets are deductible, we believe it is more likely than not that we
will realize the benefits of these deductible differences, net of the existing valuation
allowances at June 25, 2006. We have established a valuation allowance when the utilization
of the tax asset is uncertain. Additional temporary differences, future earning trends
and/or tax strategies may occur which could warrant a need for establishing an additional
valuation allowance or a reserve.(8)
    
    Employee Benefit PlansStock Based Compensation
 Axle Holdings Plan
    11




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##### Table of Contents



WeightedAverageWeighted
    
    
    Remaining
    
    
    AggregateAverage
    
    
    Contractual
    
    
    IntrinsicExercise
    
    
    life
    
    
    ValueOptions
    
    
    Price
    
    
    (in months)
    
    
    (in thousands)Outstanding at December 25, 2005
    
    
    526,704
    
    
    $
    19.33
    
    
    
    96.4
    
    
    $
    4,969Options granted
    
    
    8,000
    
    
    
    25.62Options cancelled
    
    
    (6,000
    )
    
    
    25.62Options exercised
    
    
    0
    
    
    
    0Outstanding at March 26, 2006
    
    
    528,704
    
    
    $
    19.36
    
    
    
    96.1
    
    
    $
    7,776Options granted
    
    
    22,000
    
    
    
    34.07Options cancelled
    
    
    (3,000
    )
    
    
    25.62Options exercised
    
    
    0
    
    
    
    0Outstanding at June 25, 2006
    
    
    547,704
    
    
    $
    19.92
    
    
    
    94.1
    
    
    $
    6,630Exercisable at June 25, 2006
    
    
    275,904
    
    
    $
    13.63
    
    
    
    76.2
    
    
    $
    5,051
   Three Months
    
    Six MonthsEnded
    
    EndedJune 25, 2006
    
    June 25, 2006Expected life (in years)
    
    
    6.0
    
    
    
    6.0Risk-free interest rate
    
    
    5.0
    %
    
    
    4.7-5.0%Expected volatility
    
    
    43
    %
    
    
    43%Expected dividend yield
    
    
    0
    %
    
    
    0%
   12




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##### Table of Contents



LLC Profit Interests
     (9)
    
    Commitments and ContingenciesLeasesIAAI leases certain facilities and equipment under operating and capital leases. As of June
25, 2006, IAAI had not entered into any capital leases in the current year.Texas FloodingOn March 19, 2006, the Companys Grand Prairie, Texas facility was flooded when the local
utility opened reservoir flood gates causing the waters of Mountain Creek to spill over into
the facility, resulting in water damage to the majority of vehicles on the property as well
as interior office space. We have recorded an estimated loss of $0.3 million for the three
months ended June 25, 2006 and a loss of $3.2 million for the six months ended June 25,
2006, which is comprised of an estimated $2.9 million in losses on vehicles impacted by the
flood, $0.8 million for damaged interior office space, $0.5 million related to clean-up of
the facility, and an offset of $1.0 million in anticipated proceeds from our insurance
carrier. The Company has resumed auctions at the facility. The $2.9 million loss related
to the vehicles impacted by the flood is based on post-flood auction results, including the
vehicle sale proceeds and revenue, less all related expenses. As of June 25, 2006, the
Company had sold approximately 75% of the vehicles impacted by the
 13




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##### Table of Contents



flood, resulting in actual losses of $2.2 million. Future sales of remaining flood vehicles
may differ from the Companys initial estimates.(10)
    
    Related Party TransactionsUnder the terms of a financial advisory agreement, IAAI pays Kelso an annual financial
advisory fee of $0.5 million, payable quarterly in advance, for services to be provided by
Kelso to IAAI, and reimburses Kelsos expenses incurred in connection with these services.
The financial advisory agreement provides that IAAI indemnify Kelso, Axle Holdings and
Kelsos officers, directors, affiliates, and their respective partners, employees, agents
and control persons (as such term is used in the Securities Act of 1933, as amended, and the
rules and regulations thereunder) in connection with the merger transactions (including the
financing of the merger), Kelsos investment in and control of IAAI, and the services
rendered to IAAI under the financial advisory agreement. The financial advisory agreement
also provides for the payment of certain fees and the reimbursement of related expenses by
IAAI to Kelso in connection with future investment banking services.(11)
    
    Acquisitions and DivestituresIn the second quarter of 2006, the Company acquired Indiana Auto Storage Pool Co., Inc.
located in Indianapolis, Indiana and in a separate, but related transaction, the Company
acquired Indiana Auto Storage Pool Co., Inc. located in South Bend, Indiana. The
acquisitions leverage our existing regional coverage in this area. The acquisitions are
accounted for as purchase business combinations and the results of operations of these
acquisitions are included in our condensed consolidated financial statements from the date
of acquisition.The following table reflects the unaudited pro forma results as if the acquisition occurred
on December 25, 2005 (in thousands):
 Three Months Ended
    
    
    Six Months EndedJune 25,
    
    
    June 26,
    
    
    June 25,
    
    
    June 26,2006
    
    
    2005
    
    
    2006
    
    
    2005Revenue
    
    $
    78,864
    
    
    $
    73,596
    
    
    $
    158,501
    
    
    $
    146,555Earnings (loss) before taxes
    
    
    (202
    )
    
    
    (9,056
    )
    
    
    (452
    )
    
    
    (238
    )Earnings (loss)
    
    
    (93
    )
    
    
    (9,678
    )
    
    
    (264
    )
    
    
    (4,255
    )
    14




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##### Table of Contents



(12)
    
    Subsequent EventsIn the third quarter of 2006, the Company acquired several salvage pools throughout the
United States. Each acquisition expands and complements IAAIs existing market coverage.
The acquisitions are accounted for as purchase business combinations and the results of
operations of the acquired businesses will be included in the Companys future consolidated
financial statements from the respective dates of acquisition.On August 1, 2006, the Company acquired Salvage Management of Syracuse located in Cicero,
New York. On July 6, 2006, the Company acquired Lenders & Insurers with three facilities
located in Des Moines, Cedar Falls, and Sioux City, Iowa. On June 29, 2006, the Company
acquired Gardners Insurance Auto Auction located in Missoula, Montana, and the Company
entered into a Stock Purchase Agreement to acquire all of the outstanding shares of capital
stock of Auto Disposal Systems, Inc., or ADS, an Ohio Corporation, headquartered in Dayton,
Ohio. The ADS acquisition includes seven locations in Cincinnati, Cleveland, Columbus,
Dayton, and Lima, Ohio and Ashland, Kentucky and Buckhannon, West Virginia. The aggregate
purchase price of all of these acquisitions is approximately $70.0 million, including land, machinery and
equipment, non-compete agreements, inventory and accounts receivable.On June 29, 2006, in order to fund the above acquisition activity, the Company amended and
restated its senior secured credit facilities. The amended and restated senior secured
credit facility is comprised of a $50.0 million revolving credit facility, a $195.0 million
term loan and a $35.0 million delayed draw term loan commitment. As of August 9, 2006, the
Company had not drawn on the $50.0 million revolving credit facility. The delayed draw term
loan has been reduced from $35.0 million to $10.0 million. The Company has not drawn on this
delayed draw term loan. The delayed draw term loan commitment expires six months from June
29, 2006. The term loan is payable in quarterly installments equal to 0.25% of the
aggregate principle amount, beginning December 31, 2006, with the balance payable at
maturity. Terms and conditions such as security, mandatory prepayments, and interest rates
remain the same. The senior secured credit facilities are subject to the following
financial covenants: (i) minimum consolidated interest coverage and (ii) maximum
consolidated leverage. These covenant levels have been modified as part of the credit
facility amendment.
 15




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
 The following discussion and analysis of our financial condition and results of operations
should be read in conjunction with the condensed consolidated financial statements and notes
thereto included elsewhere in this Quarterly Report on Form 10-Q (Report). This Report contains
forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of
1934, as amended, and 27A of the Securities Act of 1933, as amended. Discussions containing such
forward-looking statements may be found in this Part I, Item 2 and elsewhere within this Report
generally. In addition, when used in this Report, the words believes, anticipates, expects,
should and similar words or expressions are intended to identify forward-looking statements.
Although we believe that our plans, intentions and expectations as reflected in or suggested by
such forward-looking statements are reasonable, such forward-looking statements are subject to a
number of risks and uncertainties that could cause actual results to differ materially from the
forward-looking statements made in this Report. Many such factors are outside our control.
Consequently, these forward-looking statements should be regarded solely as our current plans,
estimates and beliefs. We do not undertake and specifically decline any obligation to publicly
release the results of any revisions to these forward-looking statements that may be made to
reflect any future events or circumstances after the date of such statements or to reflect the
occurrence of anticipated or unanticipated events. All forward looking-statements attributable to
persons acting on our behalf are expressly qualified in their entirety by these cautionary
statements. Our actual results could differ materially from those discussed in or implied by
forward-looking statements for various reasons including those discussed in the Risk Factors
section of our Form 10-K for the year ended December 25, 2005, as amended.
 Refer to IAAIs Form 10-K , as amended, for managements discussion and analysis of the
financial condition and results of operations of IAAI for the year ended December 25, 2005. The
following is managements discussion and analysis of the financial condition and results of
operations of IAAI for the quarter ended June 25, 2006.
 
 Overview
  
 Significant Items Affecting Comparability
  16




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##### Table of Contents



Acquisitions and New Operations
  
 Results of Operations
  Three Months Ended
    
    
    Six Months EndedJune 25,
    
    
    June 26,
    
    
    June 25,
    
    
    June 26,2006
    
    
    2005
    
    
    2006
    
    
    2005(dollars in thousands)Revenues:Fee income
    
    $
    66,366
    
    
    $
    61,344
    
    
    $
    133,145
    
    
    $
    122,445Vehicle sales
    
    
    11,938
    
    
    
    10,518
    
    
    
    22,812
    
    
    
    20,36178,304
    
    
    
    71,862
    
    
    
    155,957
    
    
    
    142,806Cost of sales:Branch cost
    
    
    49,975
    
    
    
    44,358
    
    
    
    98,219
    
    
    
    87,035Vehicle cost
    
    
    10,178
    
    
    
    8,827
    
    
    
    19,351
    
    
    
    17,29260,153
    
    
    
    53,185
    
    
    
    117,570
    
    
    
    104,327Gross profit
    
    
    18,151
    
    
    
    18,677
    
    
    
    38,387
    
    
    
    38,479Operating expense:Selling, general and administrative
    
    
    11,377
    
    
    
    9,173
    
    
    
    23,236
    
    
    
    19,222Loss (gain) on sale of property and equipment
    
    
    11
    
    
    
    (847
    )
    
    
    17
    
    
    
    (879
    )Loss related to flood
    
    
    310
    
    
    
    
    
    
    
    3,170
    
    
    
    Merger costs
    
    
    
    
    
    
    19,529
    
    
    
    
    
    
    
    20,76211,698
    
    
    
    27,855
    
    
    
    26,423
    
    
    
    39,105Earnings
(loss) from operations
    
    
    6,453
    
    
    
    (9,178
    )
    
    
    11,964
    
    
    
    (626
    )Other (income) expense:Interest expense
    
    
    6,741
    
    
    
    2,790
    
    
    
    13,193
    
    
    
    3,209Other income
    
    
    (123
    )
    
    
    (2,452
    )
    
    
    (246
    )
    
    
    (2,483
    )Earnings (loss) before taxes
    
    
    (165
    )
    
    
    (9,516
    )
    
    
    (983
    )
    
    
    (1,352
    )Income taxes
    
    
    (94
    )
    
    
    445
    
    
    
    (408
    )
    
    
    3,588Net earnings (loss)
    
    $
    (71
    )
    
    $
    (9,961
    )
    
    $
    (575
    )
    
    $
    (4,940
    )
 Results of Operations
 Three Months Ended June 25, 2006 Compared to the Three Months Ended June 26, 2005
   17




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Six Months Ended June 25, 2006 Compared to the Six Months Ended June 26, 2005
        18




---



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Financial Condition and Liquidity
        19




---



##### Table of Contents




    
    incur additional indebtedness, including guarantees;
 
    
    create, incur, assume or permit to exist liens on property or assets;
 
    
    engage in sales, transfers and other dispositions of our property or assets;
 
    
    declare or pay dividends to, make distributions to, or make redemptions and
repurchases from, equity holders;
 
    
    make or commit to make capital expenditures over certain thresholds;
 
    
    make loans and investments and enter into acquisitions and joint ventures;
 
    
    prepay, redeem or repurchase our debt, or amend or modify the terms of certain
material debt or certain other agreements; and
 
    
    restrict our ability and the ability of our subsidiaries to pay dividends and make
distributions.
  20




---



##### Table of Contents



TwelveMonthsThree Months Ended
    
    
    EndedSeptember 25,
    
    
    December 25,
    
    
    March 26,
    
    
    June 25,
    
    
    June 25,2005
    
    
    2005
    
    
    2006
    
    
    2006
    
    
    2006Net earnings/(loss)
    
    $
    507
    
    
    $
    (1,441
    )
    
    $
    (504
    )
    
    $
    (71
    )
    
    $
    (1,509
    )Income taxes
    
    
    (206
    )
    
    
    185
    
    
    
    (314
    )
    
    
    (94
    )
    
    
    (429
    )Interest expense (net)
    
    
    6,210
    
    
    
    5,865
    
    
    
    6,329
    
    
    
    6,619
    
    
    
    25,022Depreciation and amortization
    
    
    4,481
    
    
    
    5,515
    
    
    
    4,933
    
    
    
    5,640
    
    
    
    20,570EBITDA
    
    
    10,992
    
    
    
    10,124
    
    
    
    10,444
    
    
    
    12,094
    
    
    
    43,654Non-cash charges(1)
    
    
    
    
    
    
    
    
    
    
    887
    
    
    
    140
    
    
    
    1,027Non-recurring expense/(income)(2)
    
    
    351
    
    
    
    (171
    )
    
    
    2,866
    
    
    
    815
    
    
    
    3,861Allowance per credit agreement (3)
    
    
    1,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,000Advisory service fees
    
    
    125
    
    
    
    125
    
    
    
    125
    
    
    
    125
    
    
    
    500Consolidated EBITDA
    
    $
    12,468
    
    
    $
    10,078
    
    
    $
    14,322
    
    
    $
    13,174
    
    
    $
    50,042
 
 (1)
    
    For the quarter ended June 25, 2006, the non-cash charges included $0.1 million of
stock-based compensation expense.(2)
    
    For the quarter ended June 25, 2006, non-recurring expense consisted of $0.5 million in
acquisition related costs and a $0.3 million loss related to the Dallas flood.(3)
    
    Per the credit agreement, EBITDA was to be increased by $1.0 million for the three-month
period ended September 25, 2005, for covenant purposes only.   
    
    100% of the net cash proceeds of certain debt issuances, and sales and leasebacks of
real property, subject to certain exceptions;
 
    
    50% of the net cash proceeds from the issuance of additional equity interests; and
 
    
    100% of the net cash proceeds from any property or asset sale or recovery event in
an amount exceeding $2.5 million in any fiscal year, subject to certain exceptions and
reinvestment requirements.
 21




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##### Table of Contents




    
    borrow money;
 
    
    incur liens;
 
    
    pay dividends or make certain other restricted payments or investments;
 
    
    issue disqualified stock;
 
    
    merge, consolidate or sell all or substantially all of our or their assets;
 
    
    enter into transactions with affiliates;
 
    
    create restrictions on dividends or other payments by the restricted subsidiaries;
 
    
    sell certain assets and use proceeds from asset sales; and
 
    
    create guarantees of indebtedness by restricted subsidiaries.
   
 Item 3. Quantitative and Qualitative Disclosures About Market Risk
  22




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Item 4. Controls and Procedures.
 Evaluation of Disclosure Controls and Procedures
   23




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##### Table of Contents



Part II
Other Information
 
 Item 1. Legal Proceedings.
  
 Item 1A. Risk Factors.
  
 Item 6. Exhibits and Report on Form 8-K.
 (a)
    
    Exhibits.See Index of Exhibits(b)
    
    Reports on Form 8-KWe filed a current report on
Form 8-K, dated May 11, 2006, which contained a press release
announcing financial results for the quarter ended March 26, 2006.We filed a current report on Form 8-K, dated June 7, 2006, which contained a press
release announcing our intent to meet with financial institutions to discuss the
possibility of increasing the amount of our outstanding bank facilities to fund future
acquisitions.We filed a current report on Form 8-K, dated June 7, 2006, which contained a press
release announcing our expectations to report lower volumes in consolidated EBITDA for
the second quarter of 2006.We filed a current report on
Form 8-K, dated June 30, 2006, which contained a press
release announcing the acquisition of Auto Disposal Systems Inc. and
an amendment and restatement of our existing senior credit facilities.We filed a current report on
Form 8-K, dated July 3, 2006, which announced details of the
acquisition of Auto Disposal Systems Inc. and an amendment and
restatement of its existing senior credit facilities.
 24




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##### Table of Contents



SIGNATURES
  INSURANCE AUTO AUCTIONS, INC.Date:  August 9, 2006
    By:
    /s/ Scott P. PettitName:
    Scott P. PettitTitle:
    Senior Vice President and Chief Financial Officer
(Duly Authorized Officer and Principal Financial Officer) 25




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##### Table of Contents



Exhibit No.
    
    Description of Document31.1
    
    Certification by the CEO pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.31.2
    
    Certification by the CFO pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.32.1
    
    Certification by the CEO pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.32.2
    
    Certification by the CFO pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
 26